Over the last seven years, unit sales of new cars and light trucks in North American have risen to record breaking levels. While overall new vehicle sales have weakened in recent months, new light vehicle sales are still at record high numbers and dealership values remain strong. However, recent pressure on dealership profitability, in the form of rising expenses and large inventory levels have economists presenting mixed views over what will happen next — a plateau, a downturn or return to growth. Savvy dealers are looking at the factors driving sales and planning for the next chapter for the industry.
How strong is the market?
Some industry analysts and economists have predicted continued record-breaking sales levels, while others have maintained that the automotive industry is on an "unhealthy path" or "in a tricky spot."1 As the year has progressed, sales have remained at high levels, although not quite showing the resiliency of previous record-breaking years, with the August 2017 light-vehicle SAAR falling to 16.0 million, the lowest level since February 2014.2 Factors such as longer loan terms of up to six years (which slows consumer buying patterns), exhausted pent-up demand and a rising interest rate environment could influence this slowdown. On the other hand, positive economic trends such as high employment, credit availability and strengthening consumer confidence remain in place, could drive sales in today's automotive market.
"Record sales years do not last forever," said NADA Chief Economist Steven Szakaly adding, "What we have seen is that the industry has moved steadily toward a model that is more productive and flexible particularly on the new-car side." Because market fundamentals are still stronger than average, Mr. Szakaly maintains that "it is difficult to see sales falling below a long-run rate of 16.5 to 16.8 million. This would still represent a strong market."3
Looking out over the next few years
The sky may not be falling, but after successive years of sales and revenue growth, there isn't a better time for dealerships to look at their business plans to stave off any perceived plateau or growth slow-down. "While most dealers tend to be are optimistic about the future, their businesses are rather elastic," says Dennis Stough, Senior Vice President and Head of Wholesale Dealer Services at SunTrust Bank. "Dealerships can control a lot of factors including inventory levels, back office support and the like to instill some expense discipline. The items they can't control are large real estate notes and blue sky unsecured notes, should the interest rate environment continue to change." Mr. Stough says he is seeing some of the stronger dealerships carefully considering whether to buy new stores or add franchises, trying to delay major building projects and evaluating expense structures to stay ahead of any potential slowdown or revenue decline.
To cover all bases while a healthy sales environment is still in place, dealerships looking to manage expenses without sacrificing growth often focus on three areas: margins, real estate investments and cost of capital.
Implementing operational improvements is the most effective way to improve margins and protect against downturn. Basic improvements for dealerships come through expense control and back office staffing level management. However, a major focus on improving a dealership's absorption rate will go a long ways towards shoring up profit margins to prepare for all market conditions.
Cost-cutting strategies begin with expense control. Expense control relies on timely visibility into all vendor and employee costs. To follow the time-honored tradition of questioning every business expense, start with accurate reporting and analytical tools. With this data and a thorough review process, you can protect strategic spending — items that make or save the most money and are directly linked to your sales, customer service and defined competitive edge — and work to reduce the rest.
Getting control over expenses as they are happening provides an even higher level of control. Implementing payment strategies such as purchasing cards help give you control over purchasing while lowering payables administrative costs by automating most vendor payments. Purchasing cards provide control down to the individual cardholder or vendor level to allow your dealership to know exactly how and where procurement dollars are spent, resulting in better management of payment timing and improved cash flow management. You can also access valuable payment analytics which can help identify spending patterns and areas where vendor terms can be renegotiated more favorably.
Staffing flexibility is important when looking to increase or maintain existing margins. While sales staff is typically commission-based and flexes with sales levels, back office staff are usually paid with more fixed compensation, offering less flexibility and greater margin risk. Dealers with multiple stores can consolidate back-end functions into one central location, eliminating duplicate functions in individual locations. Single-point dealerships don't have that flexibility, but can take advantage of outsourcing functions, such as human resources and accounts payable/receivables to realize savings over on-site full- or part-time employees. Both multi- and single-point dealers can leverage savings potential by moving toward electronic payments processes. Simplified payment-related processes can lower administrative and staffing costs while eliminating fraud opportunities. Studies have found that labor costs from manual intervention — typically 62 percent of total account payable costs — can be reduced by electronic payments.4
Dealerships are in a unique position to stabilize profit margins, even in a downturn, by focusing on maintaining high service revenues and absorption rates. Best in class dealers have absorption rates well over 100 percent, making enough revenue on service, parts and back-end fees to cover all their fixed expenses. Many successful dealers are focusing on obtaining more share of wallet. "Quick lube, tires, dent repair," Penske Automotive CEO Roger Penske told an audience at an Automotive News Retail Forum, "don't let the customer get away."5 The more services you can provide your customers, the less reliance your store will have on the profitability of the sales department and the better situation you will be if the market changes.
Shifting more attention to after-market sales and higher margin used car sales also helps improve your overall profitability picture and shore up cash reserves.
Optimizing real estate investments
According to the Kerrigan Advisors Blue Sky report from June 2017, real estate is playing an increasingly important role in the valuation of a dealership. As blue sky values declined over the first half of 2017, real estate values increased, effectively offsetting any net dealership valuation loss.6 Less real estate debt only improves valuation and reduces risk from market fluctuations or revenue losses. The more cash flow you have after covering debt expense, the more flexibility you will have to weather market shocks. Many dealers today are working diligently to pay down debt. Some are even paying off their real estate debt completely to place their businesses in the most flexible position. Your banking partners can help you determine if refinancing existing loans are an option for your dealership.
Managing cost of capital
One of the largest expenses on the balance sheet, after personnel expense, is the cost of inventory. When sales are strong, floor plan costs are relatively manageable and inventory levels can be high. In a slow sales environment, managing floor plan costs will become a major focus for your team. As turn rates begin to increase, tough decisions on inventory levels will ensure you have the right balance between number of vehicles on the lot and inventory carrying costs that meet your budget without overextending finances.
Expansion plans could be another drag on capital should sales stall. Any expansion plans can be carefully examined by asking:
- How vital is the expansion to my current business?
- How will I fund the expansion? New loans, existing loans, refinance for more cash availability or self-fund?
- Will my business be able to cover the cost of expansion in a sales plateau of downturn?
The pressure from manufacturers to build newer, bigger, better facilities is ever present, but facility expansion and/or franchise/store purchases need to be weighed against the risk of a sales decline and the prospect of a continued rising interest rate environment. The cost of capital can rise dramatically with only a small interest rate bump. Make sure to talk with your banking partners to get a feel for any potential carrying opportunities you can leverage if expansion becomes a necessity for your business plans.
Covering your bases
Optimism is said to be the key to success. Optimism with a healthy dose of realism will carry the day. Preparing a business to withstand negative fluctuations in the marketplace only makes it stronger in the good times. Proactively implementing a few cost-saving strategies as outlined above can help put your dealership on the right track to handle anything the market may present in the coming years.